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Premium support proposal and critique: Objection 1, risk selection

December 13, 2011 at 6:30 am

Austin Frakt

This post is part of a series. If you haven’t read the prior posts in the series, you really should. The introduction explains what I’m doing and links to all posts to date. This post is the first of many that critique the premium support proposal I put forth earlier in this series. I presume you’ve read that, as well as the Q&A about it.

Perhaps the most common attack on premium support that includes both private plans and traditional Medicare (TM) — as does the one I offered — is that it is a death sentence for TM due to risk selection. The concern is that private plans will find ways to attract relatively healthier and cheaper-to-cover beneficiaries (the “good” risks), leaving the sicker and more costly ones (the “bad” risks) in TM. Attracting good risks is known as “favorable selection” and attracting “bad” ones is “adverse selection.”

Since plans compete based on their bids of per beneficiary cost, plans with favorable selection are at a competitive advantage relative to those with selection that is more adverse, like TM. If that happens, plans can bid lower than TM. The level of premium support, set at the lowest bid, will be insufficient to cover TM’s cost. Hence, TM will charge a premium. That premium will drive people away. If selection becomes more and more adverse for TM as people leave the plan, it could experience a “death spiral,” essentially going bust with premiums escalating to the point that nobody wants to enroll. TM would die.

OK, that’s the concern. Now let’s go into it further. First, will private plans experience selection more favorable than TM? This is an easy question. They absolutely will in general if not for every single plan. The reason is that plans must earn more than cost to survive long term. Hence, they have an incentive to find ways to attract beneficiaries that are cheaper than the revenue they receive to provide coverage for them. The plans that fail at this game go bust. The same holds for TM. The ones that remain, by definition, have succeeded in experiencing favorable selection.

One crucial difference, among many, between TM and private plans is that new private plans can enter the market while TM is just one plan. Moreover, private plans can change their nature (like extent of network, additional benefits, customer support, and whatever else is within the bounds of the law) much more rapidly and easily than TM. It’s akin to survival of the fittest where you’ve got one plan (TM) that adapts slowly, if at all, against essentially infinite plans (private ones that can enter and exit the market) that can adapt rapidly. There is no way private plans won’t experience selection more favorable than TM under these conditions.

The next question, and this is harder, is, is this game over for a premium support program that includes TM? Not necessarily. What I’ve hopefully convinced you of is that the relatively sicker beneficiaries will tend to end up in TM and they will have to pay a higher premium for it. The difference between the TM premium and those of the private market is, essentially, a tax on sick people. If we can calculate that tax, that difference, we can compensate TM’s sick enrollees for it. That’s risk adjustment. That’s supposed to be part of the plan I sketched out.

There are some who say you can never design a perfect risk adjustment system. That’s not quite true. What you can’t do is design a perfect prospective one, where you anticipate costs and adjust the level of support (plan subsidy) accordingly. Or, you can’t do it in the real world, anyway. Prospective risk adjustment still provides incentives for plans to manage costs. However, its not perfect risk adjustment because you can’t predict costs with perfect accuracy in advance, even for a population. Private plans will experience selection more favorable than that which can be addressed by prospective risk adjustment. TM’s selection will be more adverse.

But you can always compute average costs in TM vs. private plans retrospectively and compensate beneficiaries (or plans) accordingly. If you find that risk is skewed beyond that controlled by the prospective risk adjustment system, it means you’re just not paying enough more for sicker folks. The solution is to crank up the payment for the sick and/or reduce it for the healthy. It could be done retrospectively to perfectly adjust for whatever differences in risk the two plan types experienced. Unfortunately, this also removes financial incentives to manage care or provide decent care. So, really, some blend of prospective and retrospective risk adjustment is needed. And that does leave open the possibility that private plans will be overcompensated and TM will be undercompensated.

What else can you do? One thing is to not allow plan premiums to change more quickly than certain percentage (like 5%) per year. That wouldn’t solve uncontrolled selection, but it would slow down a death spiral, hopefully long enough to do something about it. Also, there can and should be monitoring of the nature of selection across the program. Plans that are experiencing selection far more favorable than is accommodated by the risk adjustment system should be ejected. Also, data should be made available to researchers to investigate selection and other aspects of the program. (Today, data on private plans is much harder to come by than that for TM.) Basically, there needs to be a full court press monitoring of selection and the ability to rapidly adjust the program if it is getting out of control.

Still, what if selection is not well controlled or adjusted for? That’s clearly problematic for anyone who wishes to preserve TM. So, what else could be done, short of completely abandoning any type of premium support different from what we have today (which has many problems)? One could consider what passed both houses of Congress in 2009-2010, competition-based premium support for private plans only, leaving TM with administratively set subsidization. That’s exactly what the ACA included, until it was amended by the Reconciliation bill in March of 2010. That’s obviously a lot different than a program that has public and private plans competing head-to-head. It would tend to depress payments to private plans, relative to what they receive today. It would be a near death sentence for private plans (some would remain, but far fewer than participate in the program today). But such a firewall would provide considerable protection for TM.

Bottom line: Selection could have consequences that many would find unacceptable and that wouldn’t bother others at all. There are things that can be done, but they may not be sufficient. Then again, they might be. Fully protecting TM from selection is possible, but leads to a very different program.

I do not see how premium subsidies would help reduce costs. There are two things that could be done to reduce spending, lower prices and reduce consumption. If you offer people a subsidy to pursue some activity requiring an input that’s in more-or-less fixed supply, the price of that input goes up. So we need perhaps increase potential supply and reduce consumption. To increase potential supply we need to make it easier to supply the goods, one possibility is to make it easier to get licences to practice medicine (MD, RN, PA, NP etc.) and to eliminate rules as to who can do what. To reduce consumption more benefit needs to go to the person who forgoes treatment.

In this case the subsidy is set at auction. (Sufficient competition is presumed or you can throw the whole idea out the window. Traditional Medicare is one of the bidders.) The bid net the subsidy becomes the premium. Now consider the incentives again.

Since it is a well-established fact that around 5 percent of the population accounts for about 50 percent of the costs of health care, wouldn’t the subsidies to those 5 percent be, frankly, astronomical? More to the point: what company in its right mind would want to take any of that 5 percent absent such an astronomical subsidy? How does this approach address the problem of the 5 percenters? If I ran an insurance company, I would be hell-bent on making sure that TM got that 5 percent and my company stayed far, far away from them as I would know that there is no way the Congress is going to pay such an astronomical subsidy for those 5 percenters. The only possible solution I can see is to require that every insurance company, including TM, take a certain number of the 5 percent. Otherwise, it would be easy to see a scenario wherein the 5 percent get, ‘magically’, placed in TM.

The 5% that uses all the money changes from year to year. Think of it this way, you as an individual are likely have most of your life time medical spending occur in one year. In many if not most cases it is difficult for insurers to know which people will be the big expenses in the future.

I understand the subsidy program for the poor; that can be easily set up. But how do we set up the subsidy program for the 5 percent? In a given year we may know that 5 percent may cost 50 percent, but do we know who the 5 percent will be? Probably not. Hence, let’s suppose that, by sheer misfortune, a company gets stuck with an inordinate number of the 5 percent. Do we, retroactively, pay that company a greater subsidy? If so, how can we manage that subsidy to promote cost effectiveness?

I follow your thinking for the other 95 percent of the population and, although I would think national health would be the proper method of insurance as is the case in virtually all civilized countries, I think your ideas have merit. I just don’t see how we can properly allocate the risk of the 5 percent. We are talking about a staggering amount of money for that 5 percent; sums that really, have never been discussed much, if at all, in political policy discussions and certainly the vast majority of Americans have absolutely no idea that 5 percent of the population is really the driving force behind health care costs. Suppose the government sent a mailer to every American detailing the cost of the 5 percent; do you think the other 95 percent will still want to subsides them?

Anyway you look at it, at some point, we are going to have to make the 5 percent pay more, probably a lot more, or not give them all the care traditionally given; or make providers take a hair-cut, or pass the cost on to the other 95 percent. It would seem your subsidy idea, if not funded properly, would force providers to take the hit.

Do you think they are willing to do that? As you can tell, the whole subsidy issue really bugs me.